Risk-On — Technology Rallies, but XLY and XLC Fail to Confirm

Risk-On Relative Strength: Technology, Consumer Discretionary and Communication…

In the chart presented below, we can observe the relative strength ratios of the three sectors traditionally associated with a greater risk appetite — Risk-On — namely Technology (XLK), Consumer Discretionary (XLY) and Communication Services (XLC), all compared against the SPX index, with the aim of understanding not only their absolute performance but, above all, how each of these segments is performing relative to the broader market. This is precisely the meaning of relative strength, a concept that allows investors to assess an asset's ability to outperform or underperform a given benchmark over time: when the ratio between two instruments rises, it means the asset in the numerator is performing better than the one in the denominator, while when the ratio falls, it means it is progressively losing ground relative to the chosen reference.

Communication Services · XLC

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This reading takes on particular significance in the current market environment because, despite the S&P 500 continuing to show strength, looking beneath the surface of the index reveals a divergence among the three main Risk-On sectors, which are not participating in the move with the same intensity. Technology continues to outperform the SPX, with XLK having set new highs and remaining one of the primary drivers of the broader index's rally, thus confirming a still-solid structure both in price terms and in terms of relative strength. The picture changes considerably, however, when we shift our attention to Consumer Discretionary and Communication Services, whose XLY/SPX and XLC/SPX ratios continue to show weakness and point to persistent underperformance relative to the market. The divergence becomes even more apparent when looking directly at the price of the two ETFs: neither XLY nor XLC participated with any meaningful strength in the rally recorded by the market last week — behaviour that suggests the index's positive performance continues to be driven primarily by Technology and, most likely, by a narrow set of industries and stocks within it, rather than by genuinely broad-based participation among the main risk-sensitive segments. It is precisely this lack of breadth that represents the element warranting the closest attention, because a structurally healthy bull market should, over time, be accompanied by progressively wider participation from Risk-On sectors. While it is not necessary for all segments to rise simultaneously or with the same intensity, it would nonetheless be desirable to observe a gradual extension of strength across a broader portion of the market. When, instead, the move remains concentrated in a handful of segments or a limited number of stocks, the rally can become more fragile and increasingly dependent on the ability of those few leaders to continue supporting the entire structure — and may also prove more susceptible to speculative flows than to a genuine expansion of market participation. This does not necessarily mean that the S&P 500 rally must come to an end, nor that the strength displayed by Technology should be interpreted negatively, but it does render the overall structure less solid than it may appear when looking solely at the performance of the index, which is why a new S&P 500 all-time high should not automatically be regarded as confirmation of broad market strength. Confirmation of a healthier and more broadly participated Risk-On environment would instead come from an improvement in XLY and XLC both in price and in relative strength against the SPX, with the two sectors needing to begin recovering ground relative to the index and following, with greater conviction, the move already established by Technology. Until this evolution begins to materialise, it will therefore be advisable to maintain a cautious stance and continue to manage trades and investments in a measured and particularly conservative manner, avoiding the automatic interpretation of every new index high as generalised confirmation of strength — because at this stage, the true confirmation of a more solid Risk-On market will not come simply from a higher S&P 500, but from a broader and more uniform participation by the sectors that should accompany its move.